Trade is the exchange of products between countries. When conditions are right, trade brings benefits to all countries involved and can be a powerful driver for sustained GDP growth and rising living standards
One way of expressing the gains from trade in goods and services is to distinguish between static gains (i.e. improvements in allocative and productive efficiency) and dynamic gains (i.e. gains in welfare that occur from improved product quality, increased choice and faster innovative behaviour).
Gains from Trade – Understanding Comparative Advantage
First introduced by David Ricardo in 1817, comparative advantage exists when a country has a ‘margin of superiority’ in the supply of a good or service i.e. where the marginal cost of production is lower
Countries will generally specialise in and export products which use intensively the factors inputs which they are most abundantly endowed
If each country specializes, total output can be increased leading to better allocative efficiency and welfare.
Because production costs are lower, providing that a good price can be found from buyers, specialisation should focus on goods and services that provide the best value
In many countries, comparative advantage is shifting towards specialising in producing and exporting high-value and high-technology manufactured goods and high-knowledge services
Example of Comparative Advantage
Usually we take a standard two-country + two-product example to illustrate comparative advantage.
|OUTPUT BEFORE SPECIALISATION||Digital Cameras||Vacuum Cleaners|
Stage 2: Showing the Output after Specialisation
|output after specialisation||Digital Cameras||Vacuum Cleaners|
|UK||0 (-600)||1200 (+600)|
|United States||3360 (+960)||600 (-400)|
For mutually beneficial trade to take place, the two nations have to agree an acceptable rate of exchange of one product for another. If the two countries trade at a rate of exchange of two digital cameras for one vacuum cleaner, the post-trade position will be as follows:
Stage 3: Showing the Gains from Trade - Post Trade Output / Consumption
|Digital Cameras||Vacuum Cleaners|
Compared with the pre-specialisation output levels, consumers now have an increased supply of both goods
Exam tip: It is useful to learn a numerical example to illustrate comparative advantage for use in an exam
What are the key assumptions behind this theory of trade?
This theory of trade based on comparative advantage rests on a number of assumptions: